Seriously affected by the global financial crisis, falls in Japan’s residential property prices accelerated during the first half of 2009.

The urban land price in Japan’s six largest cities dropped by 7.8% (9.2% in real terms) in H1 2009 from the previous year, according to the Japan Real Estate Institute (JREI), ending the long-anticipated recovery of Japanese property prices.

In Japan, land prices serve as a proxy for home prices. Land prices in the six largest cities rose by 2.8% (2.8% in real terms) in 2006, 8.1% (8.1% in real terms) in 2007, and 1.1% (a fall of 0.2% in real terms) in 2008.

On a national level the price of land has been falling since H2 1991. Since the second half of 2007, land price decreases in Japan have accelerated. Land prices slid 3.4% (4.9% in real terms) in H1 2009 from the previous year.

Land prices are used as a measure of residential property values partly because Japan is earthquake-prone, making the value of land more significant than the houses built on them.

New building permits in 2008 continued to be below 2006 levels, due to tighter constructions laws. Banks remained extremely cautious, making it difficult for buyers and developers to acquire loans.

The economy however grew in Q2 2009 after four consecutive months of contraction due to the aggressive government stimulus and tax reforms. As long as the economy is able to sustain the growth, the residential property market is expected to gradually recover, according to Credit Suisse.

A textbook example

Japan’s property bubble was a textbook example of how fast economic growth combined with loose monetary conditions can lead to asset price bubbles. Japan had one of the highest economic growth rates in the world from the 60s to the 80s, growing annually by an average of 8%.

Massive speculation in the commodities and real estate markets emerged as a result of PM Tanaka Kakuei’s macroeconomic policies in the 70s, with uncontrolled increases in the money supply. Land prices rose 213.4% (85.3% in real terms) in the six biggest cities, and by 178% (22.7% in real terms) nationally during the decade to 1980. From 1980 to 1990, land prices in the six biggest cities rose by another 251.2% (179.7% in real terms), while national land prices climbed 119% (44.3% in real terms).

In the late 80s, monetary policy was suddenly tightened, and this led to the biggest financial crash in modern Japanese history. The real estate bubble finally burst in 1991. Three-quarters of local banks’ lending was to small businesses, which had properties as collateral. The property crash crippled the banking sector, as the amount of bad loans skyrocketed to almost USD1 trillion. This led to more than a decade of stagnation and deflation, known as Japan’s lost decade.

Real estate sector hard hit

The global financial crisis and Japan’s recession bit hard in 2008. Land sales noticeably dropped by 10.1% in 2008, while Tokyo land sales registrations dropped no less than 15.7%. Sales in Osaka and other cities also slid, falling by 8.5% and 7.6% in 2008, respectively.

Condominium sales in Tokyo continued to drop in 2009, declining by an average of 19.4% from January 2009 to August 2009 from the same period last year, according to data from the Real Estate Economic Institute. This followed the 28.3% drop in condominium sales in 2008. Sales in Tokyo have been declining since 2004, when 85,000 condominium units were sold.

Real estate developers and investors have been heavily affected. Bankruptcies in the real estate sector rose by 41%, to 284 firms in H1 2009 from the same period last year, according to Teikoku Databank. Major developers Joint Corp. and Japan General Estate Corp. both filed for bankruptcy protection, with liabilities worth US$1.5 billion and US$2.2 billion, respectively.

One of the biggest buyers of real estate properties from 2005 to 2007 were J-REIT investors. The onset of the financial crisis caused interest to collapse, and as of September 2009, the TSE-REIT Index is 64% below its peak.

Tight construction laws

By a perhaps unhappy coincidence, the government implemented tough new building regulations in 2007 and 2008, after a scandal in the real estate industry in 2005 exposed the flaws in Japan’s building laws.

The Act for Execution of Housing Defect Warranty Liability under the Housing Quality Assurance Act was signed in May 2007. It requires developers to have sufficient funds to cover expenses resulting from property defects.

Amendments to the Building Standard Law were implemented in June 2007, which require more safety inspections and certifications, and a longer building confirmation period.

The Kenchikushi (architect) Law was amended and implemented in December 2008, requiring architects to attend regular educational seminars and have buildings certified first-class architects.

The number of new projects has dropped due to the new laws. Housing starts in 2008 were 15.3% below the 1.3 million registered housing starts in 2006. Housing starts are expected to fall again in 2009. From January 2009 to August 2009, registered housing starts dropped by an average of 28.8%, according to data from the Ministry of Land, Infrastructure and Transport (MLIT).

Very cautious mortgage market

Japan’s mortgage market, with a ratio of outstanding home loans to GDP below 25%, remains one of the smallest in the developed world.

Japanese banks continue to be very cautious about granting new loans. Foreign buyers, particularly, undergo a long credit approval process, and are required to have permanent residency and a Japanese guarantor to get a loan.

Homeowners are experiencing difficulty paying for their loans. However, Japanese non-performing loans (NPL) ratios are low, largely because of reforms enacted by Junichiro Koizumi, prime minister from 2001 to 2006. From a high of 8.7% in March 2002, the ratio of NPLs to total loans decreased to 1.4% in March 2008, according to the Financial Services Authority (FSA). Due to the global financial crisis, the ratio of NPLs to total loans increased to 1.7% in September 2009.

Part of Koizumi’s reforms in the financial sector was the transformation of the Government Housing Loan Corporation (GHLC) into the Japan Housing Finance Agency (JHF). The JHF focuses on securitizing mortgage debt to “enable private financial institutions to create a steady supply of long-term fixed mortgage loans” instead of providing loans to households. The reform aimed to stimulate lending by private institutions. It has not visibly succeeded.

Stable interest rates

Since the mid-1990s, the BOJ key rate has remained below 1%. The BOJ implemented a zero interest policy for most of the period from March 1999 to July 2006. The BOJ then raised the key rate up to 0.5% from February 2007 to September 2008. With the global financial crisis, the BOJ cut the key rate twice in 2008, to its current level of 0.1%.

Bank variable interest rates have hardly moved in Japan since 2000, standing at 2.745% since September 2009.

Yields are moderate to good in Japan

The Japanese rental market is strongly pro-landlord and involves a long process before one can rent a residential property. A deposit of about five to seven months’ worth of rent, including one to two months’ worth of rent as a “gift” to the owner, is required prior to the signing the contract. Foreigners would have more difficulty in finding available residential properties for rent as some owners are reluctant to rent to foreigners, and a Japanese guarantor is mandatory.

Despite the rental market issues, the average rental yield for residential properties in Tokyo was 5.5% in March 2009, according to Global Property Guide research. A 40 sq. m. apartment generates the highest yield of 5.9%, while a 250 sq. m. apartment only yields 5.2%.

Although rents have declined since 1995, property prices dropped at a faster pace in the same period.

From 1995 to 2008, rents fell by 11.2% while property prices slid 35%, according to JREI. With property prices falling, young people tend to prefer renting, while individuals migrating to urban areas from rural areas create another source of rental demand.

Further stimulus measures

In April 2009, the government announced a stimulus package worth JPY15.4 trillion (USD173 billion), the biggest of all those announced since 2008.

JPY3 trillion (USD33.7 billion) is allocated to strengthen the financial sector, which includes the easier facilitation of financing for mortgages and land purchases.

JPY6 trillion (USD67.5 billion) is available for construction of environmentally-friendly residential properties.

Aside from the stimulus package, the government announced tax reforms in December 2008.

Application of tax credits relating to mortgages is extended by five years, while the maximum eligible amount for tax deduction is raised to JPY5 million.

For properties held for at least five years, sellers will receive capital gains tax deductions of up to JPY10 million, if the property is sold between 2009 and 2010.

The 1% tax on the registration and license on land sales is extended up to 2011.

In August 2009 elections the Democratic Party beat the Liberal Democratic Party (LDP), which had ruled Japan for over 50 years - and which had introduced the latest stimulus package and tax reforms.

Skeptical of the LDP economic policies, new PM Yukio Hatoyama is committed to overhauling government spending, social security nets and Japan’s reliance on exports.

This may lead to the ineffective implementation of the new measures, despite their potentially positive impact on the market.

Out of recession

Japan’s economy grew 2.3% in Q2 2009 from the previous quarter. The recovery is due to the government’s three stimulus packages, which have pumped a total of JPY29.4 trillion (USD301 billion) into the economy. Public investment increased by 33.6% in Q2 2009 from the previous quarter. Foreign demand returned as exports increased by 28.1% in Q2 2009 from the previous year, following the 63.9% plunge in exports in Q1 2009.

Despite the growth, the economy is expected to contract by 5.2% in 2009, according to the IMF. Private investment and private demand fell by 17.9% and 6.5% in Q2 2009 from the previous quarter.

Deflation accelerated to 2.2% in August 2009. Unemployment rose to 5.7% in July 2009, with around 3.8 million unemployed.

A recovery in the residential property market is nevertheless expected, as consumer confidence is slowly increasing, according to Credit Suisse. For the market to recover, the government must continue to implement policies that would strengthen the residential property market.